What is an investment bond?
Investment bonds are pooled investments, like managed funds, which can be invested across a variety of asset classes to create diversification. One of the important differences between an investment bond and a managed fund, is that investment bonds are tax-paid. That means tax is paid on the earnings of the underlying investments by a life insurance company (or friendly society) and not by you.
Tax on earnings within the bond is paid at the company tax rate of 30%, and any realised capital gains are not discounted. If held for 10 years – and the 125% rule is not breached - no further tax is payable when the funds are withdrawn. The 125% rule requires that contributions in a year do not exceed 125% of the previous year’s contributions. If the 125% rule is breached, the 10-year period is restarted.
Whilst withdrawals can be made at any time, those within the first 10 years result in some or all of the growth being assessable, the taxpayer must include this in their tax return. A 30% offset is available to reflect tax paid in the bond.
Financial advice and investment bonds
Whether an investment bond is a suitable investment depends on a person’s objectives and their personal circumstances.
Here are two examples of where an investment bond could provide benefits:
Grant, age 50, is a high-income earner with surplus cash to invest. He has more than $2.5 million in super and therefore cannot contribute further. An investment bond allows him to invest with earnings taxed at 30%, rather than his marginal rate of 47%.
Meg and Ollie want to save funds for the secondary education of their two young children. An investment bond enables them to accumulate returns taxed at a maximum of 30%, and funds can be withdrawn tax free after 10 years. The investment earnings are not added to their personal taxable income which may also assist with Government benefits, such as the Child Care Subsidy.
The benefits of investment bonds for estate planning
Investment bonds are classified as life policies. Upon the death of the life insured, the proceeds are paid to the nominated beneficiary or the policy owner if no beneficiary has been chosen. If the life insured is the policy owner and there is no beneficiary, then the proceeds are paid to their estate. Unlike super, there is no restriction on who is an eligible beneficiary; individuals, companies, trusts or charities can be nominated.
Investment bonds can therefore be a powerful tool for intergenerational wealth transfer, as they can be set up to directly transfer to a named beneficiary upon the investor’s death. This transfer is outside of the will, bypassing probate and estate administration. This means the bond proceeds are generally not subject to estate challenges, as they will not form part of the estate assets (except possibly in NSW where they may be considered part of a ‘notional estate’). The tax-paid status of the bond also means that beneficiaries receive the proceeds tax-free, even if the 10-year period has not been completed.
Some examples of using of an investment bond as an estate planning tool are:
- providing for children from previous relationships or blended families
- addressing potential conflicts and inequities between beneficiaries that might be complex and difficult to handle under a will
- making charitable bequests
- gifting for milestones, for example, a grandparent may want to provide funds to their grandchild upon turning 21 to assist with a housing deposit.
Examples
Nico, a widower, age 78, has two adult non-financially dependent children. He has surplus cash and wants to ensure on his death, the funds pass equally to his two children whilst avoiding possible disputes over his estate. His financial adviser recommends establishing an investment bond and nominating his two children as equal beneficiaries. This allows him to pass his savings to his children tax-free and bypassing his estate. Additionally, provided he doesn’t withdraw from the investment bond, he doesn’t need to include it in his tax return nor declare it for the Commonwealth Seniors Health Care Card.
Lucie, age 80, would like to ensure $100,000 of her estate is passed to her six-year-old granddaughter Zoe to help with future expenses such as university fees or a home deposit. Her financial adviser recommends an investment bond with Lucie as the owner and Zoe as the beneficiary. Upon Lucie’s death, the bond passes tax-free to Zoe.
Alternatively, a child advancement policy could be used. A child advancement policy is an investment bond arrangement where the life insured is a child, the policy is set up before the child has reached 16 years and the policy provides for the payment of the proceeds to the child when they reach a specified vesting age (from age 10 to 25). Once the child reaches the specified age, the policy becomes the property of the child.
In this example, Lucie can stipulate in her will that, should she die before the policy has vested to Zoe, the policy is to be held on trust for her until she reaches the vesting age.
Get the right advice
Investment bonds are a well-established, yet sometimes overlooked, investment and estate planning tool. They can offer:
- tax efficiency for high-income earners and persons ineligible to contribute to superannuation
- flexibility and accessibility of funds, although withdrawals within the first ten years reduce the tax benefits
- certainty and speed in transferring wealth to future generations.
Like any investment vehicle, they have their drawbacks including:
- investment bonds can carry a variety of fees, and depending on the type and provider, those fees may be high compared to other investment options
- complexity in tax rules around 10-year periods and 125% contributions limits, which if misunderstood can lead to poor outcomes
- potential lower returns than alternative structures, due to higher internal tax, fees and often more limited investment choice.
Like any investment, investment bonds won’t suit every person, such as individuals on lower marginal tax rates, those needing regular income and short-term investors. For tailored advice, talk to a qualified financial adviser to determine whether they align with your financial and estate planning objectives.
Brooke Logan is a technical and strategy lead in UniSuper's advice team. UniSuper is a sponsor of Firstlinks. Please note that past performance isn’t an indicator of future performance. The information in this article is of a general nature and may include general advice. It doesn’t take into account your personal financial situation, needs or objectives. Before making any investment decision, you should consider your circumstances, the PDS and TMD relevant to you, and whether to consult a qualified financial adviser.
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